SEC Reviews Controversial Bond Pricing Disclosure for Retail Clients

Almost two years after proposing a controversial rule that would require firms to disclose bond markups to retail customers on trade confirmations, regulators are nearing the final leg of the process.

The Securities and Exchange Commission on Monday said it will accept comment on the proposed Financial Industry Regulatory Authority for 21 days. Finra has already made revisions in its initial proposal of November 2014 in response to claims that additional disclosure could confuse investors and potentially drive some firms from retail bond sales.

The in dollars-and-cents and percentages the markups and markdowns they charge relative to prevailing market prices on bonds bought and sold to retail customers. The disclosure would be required on bonds that firms buy or sell as principal on the same day that they fill similar-sized retail orders.

The Finra rule applies to corporate bonds and agency securities. The MSRB expects to file an almost identical rule regarding municipal bond transactions within the next two weeks, according to MSRB Executive Director Lynnette Kelly. The SEC has final authority over Finra and MSRB rule proposals, and Chairman Mary Jo White and several commissioners have already expressed support for the markup disclosures.

The rules will encompass a wide swathe of bond trade transactions that, unlike equity securities, cannot be priced easily by retail investors because there are so many publicly traded bonds that are priced differently by different dealers.

About 59% of retail-size customer trades in corporate debt securities made in the third quarter of 2015 would have been subject to the disclosure requirement if the proposed rule had been in place, the Finra rule said.

“Finra believes that some customers pay materially higher mark-ups or mark-downs in retail size trades than other customers for the same fixed-income security,” the self-regulatory organization wrote in an explanation of its rule proposal. “[T]he proposal will better enable customers to evaluate the cost and quality of the execution service that member [firms] provide [and] will promote transparency into firms’ pricing practices.”

The rule proposal does not prescribe how firms should determine a “prevailing market price” but suggested that the same-day pricing provision would provide a close proxy. In their initial proposals, Finra and the MSRB proposed requiring markups or markdowns from a so-called reference price based on bonds bought or sold out of inventory, a calculation that industry commenters said would be difficult, if not impossible, to determine and lead some firms to game the system by waiting more than 24 hours to fill a trade order.

The final proposal also eliminated a definition of a retail trade as one involving 100 or fewer bonds, or involving bonds with a face amount of $100,000 or less. That definition could have excluded retail customer transactions above that amount or subjected some low-volume institutional transactions to the rule, commenters said.

Using standard industry distinctions between retail and institutional should simplify the procedure, regulators said.

The Finra proposal acknowledges that the prevailing market price of a particular security may not be identical across firms. However, it said firms will be required to have “reasonable policies and procedures in place to calculate the prevailing market price and that such policies and procedures are applied consistently across customers.”

Finra’s initial rule proposal drew sharp criticism, with only six of 31 commenters supporting it, and most of those from outside the industry, the SEC said. The Securities Industry and Financial Markets Association, the principal trade group of the industry, said additional disclosure could confuse investors, raise pricing because of expensive systems changes that firms would have to implement and even drive smaller bond dealers out of the business.

In response to some comments on the original proposals suggesting that firms merely provide links to Finra’s bond-pricing database known as TRACE and disclose the time of the trade on customer confirmations, the SEC said in a footnote that Finra “intends to submit a rule filingin the near future that proposes these requirements.”

This is getting beyond ridiculous. Are department stores forced to reveal how much profit they make on a pair of shoes? Car dealerships on every vehicle delivered? Home flippers on how much they make on each transaction? NO. This singling out of the securities industry is getting tiresome, and regulators need to be reigned in on the issue of disclosing profits. Fees yes, profits no!

I agree, when health insurance contracts are no longer unilateral, when contracts between insurers and providers do not predetermine the depth of the bankruptcy I will be happy to start worrying about bond pricing transparency. Client purchases 100k of a 10 year bond broker gets a point or 1000 dollars for his efforts, client holds the bond to maturity, that means the broker makes a whopping 8.33 a month over a 120 months and will not have another trade(assuming it is a commission based client) for 10 years. Obviously, the investor is truly getting torched for 8.33 a month and if it is a 30 year bond, well that means the advisor, that cunning Diamond Jim, hewould pull a robust 2.77 a month over 30 years what a demon!!!!

Price transparency is a reasonable goal. I have been involved in fixed income business for more than 30 years. (One of the first 5,000 Bloomberg subscribers). I have been in sales, PM but mostly in trading.

For instance charging $50 on a $5,000 face bond trade is equal to a full point markup. That markup is unheard of in a plain-vanilla institutional trade. Since there are no trailers on this transaction that $50 is supposed to cover the processing costs, the time involved by the salesperson to transact the sale and the trading desk time. The firm is already losing money. That assumes the trade is mistake free and doesn’t require additional time. If you add more regulatory costs, the financial burden can only be absorbed by other profitable trading usually associated with a select group of large firms.
This will reduce competition and likely increase retail pricing especially for bids during market illiquidity. The issue is complex.

Sometimes cures create more problems than the issue they were intended to rectify.

Agree on cures causing more issues- especially government regs. But to level the playing field disclose the commission to retail buyers- if they don’t want to pay it then they can do something else. The cost of the commission or markup if the cost of doing business if its 1 point then so be it.

Government needs to go after and make mutual fund fee transparent also.

It’s a great start. Now lets make sure car dealers show you exactly how much they pay for a car, including back end manufacturers incentives bonuses etc. Liquor stores must post the actual cost of a bottle of wine or scotch so that we can tell exactly what they’re making and how badly we are getting screwed. Politicians should post exactly how they became multi-millionaires while “serving the public”. Rafi the hot-dog vendor on on 47th and Broadway MUST tell us his exact cost of goods. I think you get my point.

I agree with the other commenters. When I go to the grocery store and buy a gallon of milk for $5.00, I know that the grocer didn’t pay $5.00 for that gallon. That’s the price I pay to not have my own cows, milk them, and process and bottle the milk. The farmer, distributor, and retailer are allowed to all make a living without government stepping in and tell them to put on the milk jug how much it cost them. I am getting very sick and tired of over regulation in this industry. I might just have to give the government what they want and switch careers. If all of the smaller firms out there just quit, all that will be left would be the few large giants – all of whom have actually pled guilty from time-to-time to blatantly committing fraud yet still exist and NO ONE goes to jail. They just pay the government pennies and continue to rip off John Q. Public. Yet since I am the small guy and can not afford to pay the penalties these guys pay, I actually have to be honest and do the right thing for my clients so I can stay in business. The government doesn’t need to tell me this. According to them, I am the crook since I would like to be able to pay my mortgage and feed my family. Gimme a break…. just me venting…sorry.

Sorry but the grocery and department store analogies just don’t cut it. Store employees are not required to be individually licensed to sell a customer their product as they are in this industry nor are store customers required to be compliant with laws and regulations such as AML and the Patriot Act prior to conducting a purchase.

Transparency in pricing is a good thing – unless you’re hiding something. That is why websites like True Car have flourished. It provides clients insight as to what they SHOULD be paying. Times are changing and FAs/RIAs should be more concerned with losing clients altogether to robo-advisors rather than whether or not they should be required to disclose their mark up on a retail fixed income trade.

Transparency, interesting, the same transparency banks make regarding what their stake in Fed profits are? The same transparency health providers and health insurers share with customers regarding what your share of cost shall be regarding a given medical procedure. Yes, there are many necessary protections needed for consumers but only in election years do Wall St. innovations seam to come into play. Since transparency in pricing is a good thing what is the cost of our purchasing power, why are banks not transparent with that. Why are loan shark rates allowable within the “Fair Credit Reporting Act?” Oh, when was the last time in any other industry you had the opportunity to see a bid and ask price, there isn’t one in the grocery store you either have the price that was DICTATED to you or go home with out it. I don’t see the grocery store telling me what he paid the farmer.

Some of you aren’t quite understanding the story here. What this boils down to is wirehouses often sell their own inventory, thereby masking the fact there are more incentives to recommend that bond over another.

The simplest analogy is walking into a boutique clothing store. The sales person sees you like a pair of Dolce & Gabbana jeans at $400, but recommends a different pair is a higher quality (aka more suitable for you), at the same price of $400. What they don’t disclose is that the boutique actually owns that other brand (thereby making a larger profit vs Dolce).

This industry used to be interesting and exciting (34 years ago). Now it’s terrifying. The majority of firms are doing the right thing and people in my position find the others and get them out!!! There will be fewer of us with all these new regulations (DOL). We are getting burnt out and the regulators are just dumping more on us. I see a lot of people leaving and it’s harder to find replacements. I’ve been saying they should post mark up on the confirms and statements for years!!! Instead, it’s hidden until I have to call your client and explain it to them…bad idea… One more thing… do the regulators disclose exactly where all the ticket charge dollars go and what they’re used for? How about the registration fees to be licensed in the states? Does it really cost $300 to be licensed in TX? What about the tax that TN charges just to do business there? I bet NOT…

Good to read some people are awake and responding. But, are we kidding ourselves? I have been working at wirehouses for 30+ years where the Bond Desk has been a profit center. I have found so many of the traders are ripoff artists (permitted by theirs supervisors – who are not worthy of their higher pay grade because of their lack of oversight). So many of the $$million dollar trades I put in were “Fill or Kill” yet 20 minutes later the trader wanted to argue with me over my credit saying “the market moved.” To best serve my clients’ interests, and remain calm and focused on my primary job, I’ve had better results hiring professional money managers who actually buy the paper at wholesale without niggling handling fees, etc., or wasting my valuable time. Or perhaps you can join Ameriprise Financial, like I recently did, because at Ameriprise Financial their bond desk is NOT a profit center. My belief is that all of our firm affiliations should join together to be the torch bearers on behalf of their soldiers, because we carry all the burden. Tsk, tsk, tsk….. we need leaders not cowards at the helm and I don’t see many. All of the firms’ leaders need to get together and defend our industry from this undue regulation (and hire great attorneys like David Boies) instead of acting like (and being) sitting ducks!